David Rosenberg: Bears ganging up on loonie are wrong — here’s why it will rebound

David Rosenberg: Canadian dollar will rebound

My, my, but it has become so fashionable now to be bearish on Canada. It is all rather surreal. Bloomberg News recently ran a story headlined, “Carney Legacy Revealed in Loonie Sentiment Reversal” and another major newspaper blared “U.S. analysts becoming increasingly skeptical about Canadian economy.”

Never mind there are signs the correction in the Canadian housing market is looking to be in its mature stage, with builders moving aggressively to bring production into line with household formation rates. And as good as the U.S. jobs data were on Friday, Canada did even better on a proportional basis. Employment here jumped 50,700, well above the average forecast and more than offsetting January’s 21,900 decline.

The national unemployment rate held steady at 7%, and, in contrast to the U.S., more Canadians participated in the labour force with the “part rate” ticking up a 10th to 66.7%. Not only that, full-time jobs surged by 33,600, the most in three months (17,200 part-time jobs were also created during the month, the most since August).

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Both the unemployment and inflation rates are lower in Canada than in the U.S., which attests to the view that supply-side economic fundamentals in Canada are beginning to outshine what we are seeing stateside.

The Canadian banks just finished a record quarter for earnings and while they trade more expensively than their U.S. counterparts, the dividend yield for domestic financials stands at 4% on the nose, versus 1.8% down south. Canada is seeing capex-led economic growth and productivity here is actually performing better on a comparative basis.

To be sure, the loonie needs a catalyst, and it could well be the approval of the Keystone XL pipeline. In this sense, it was highly encouraging to see Barron’s cite sources over the weekend suggesting that this has a better than 50-50 chance of occurring by late summer. The impact on redressing the Canadian oil price discount and our country’s balance-of-payments would be enormous, considering the energy trade surplus has been sliced by nearly 12% in just the past 12 months.

Sentiment on the Canadian dollar has become so depressed that it would probably not take much in the way of any good news to spark a turnaround

Our measure of fair value on the loonie is 97-98¢, where the Canadian dollar is right now. Overshoots in upside spasms and undershoots in corrective phases tend to occur, but the undershoots this cycle have been short in nature. They have also tended to serve up windows of opportunity for those U.S.-based investors with long time horizons that are patiently building positions in a currency backed by hard reserves in the ground, a central bank with a price stability goal, a AAA national balance sheet (even with the provinces added in, the debt ratio in Canada is far below comparable U.S. and OECD levels — Canada currently at 79%, U.S. at 108% and OECD average at 109%) and a government that is being run by pro-business conservatives.

Remember the Canadian dollar last June dropped below fair value (96¢ at the time) and was left for dead (as is now the case, too), but it turned into the best buying opportunity of the year.

One recent concern for the Canadian dollar was the growing money market view that the Bank of Canada will possibly cut interest rates in the coming year. No such indication was given by the central bank in last week’s press statement. While less hawkish than in the past, the BoC is one of the few globally retaining a de facto “tightening bias.” This alone builds an effective floor under the dollar, even during this current corrective phase.

Considering Canada has three times the exposure to commodities that the U.S. does in virtually every respect, another catalyst would be a pick-up in the Chinese economy, which would help provide renewed thrust to the resource market. Certainly, the latest stream of below-expected retail sales, credit and industrial production data for February in China were not helpful in this regard. The news that the inflation rate there rebounded to 3.2% in February from 2% for the highest pace since April of last year also places near-term limits on any easing prospects by the People’s Bank of China.

The current regime has recently been taking measures to curb speculative excess in the housing market and clamping down in terms of more aggressive anti-corruption measures, which have dampened the high-end retail sales market. So the key question ahead is the extent to which these measures adopted by departing Premier Wen Jiabao will provide the incoming government with a springboard for more pro-growth initiatives. This, too, would be an external catalyst for a Canadian dollar rebound.

One thing seems certain: Sentiment on the Canadian dollar has become so depressed that it would probably not take much in the way of any good news to spark a turnaround. The speculators in the CME have swung from a total net long position at the end of 2012, in both the futures and options market, of 63,166 contracts to a net short position of 44,205 contracts.

First, this is the most violent 10-week move ever from bullish to bearish positioning. Second, we have not seen such a large net short position by non-commercial accounts in six years and this is actually double what we saw in the darkest days for the loonie back in the depths of the Great Recession in early 2009.

Some back-of-the-envelope work would suggest this level of net shorts suggests the market is now pricing in a move down toward the 85¢ level. In other words, a lot of bad news is being priced in right now, and it may be time to contemplate what could happen if the bad news proves overdone and these flows on the CME swing the other way again. The last time the market was this negatively positioned, the loonie enjoyed a 10% appreciation in the ensuing three months.

David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates Inc. and author of the daily economic report, Breakfast with Dave. He is one of FP Magazine’s 25 Most Influential People in Canada.

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